[ForexNews]

The ECB policy meeting is on 7th May. At the press conference on 2nd April, President Trichet indicated that the Council would expand on the topic of ‘unconventional policies’ on this occasion.The majority of economists expect a 25bp cut in the main refi rate to 1%, a further lengthening of the ‘fixed rate full-allotment’ refinancing operations from the current 6-months to 9-12-months and, possibly, the launch of a program to purchase investment grade corporate securities in the secondary market.

The Currency: Since QE announcements have typically resulted in a weakening of the exchange rate, the recent price action could be taken to suggest that the forex market is anticipating a move in this direction next week. However, the cross has tracked the differential between USD and EUR rates closely. The yield spread has moved in the Dollar’s favour mostly because US rates have moved higher rather than EUR rates lower. Further, the option market (25 delta ‘risk reversals’) does not point to any skew in favour of EUR short positions. Ahead of the policy meeting, one position to consider is short EUR/GBP, consistent with view that the cross is too high given the relative cyclical performance of the two countries, and the relative expected policy rate trajectories. To illustrate, a 3-mth binary EUR put/GBP call struck at 0.8250 (29 July expiry) costs around 11.75% of the payout.